ATO Interpretative Decision
ATO ID 2011/22
Income Tax
Commercial debt forgiveness: whether the notional value of a debt can be less than its face value if the debtor is solventFOI status: may be released
This ATOID provides you with the following level of protection:
If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
Can the notional value of a fixed term debt for the purposes of the debt forgiveness rules in subsection 245-55(1) of Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936) be less than its face value if the debtor is solvent at all times?
Decision
Yes. In determining the notional value of the debt under subsection 245-55(1) of Schedule 2C to the ITAA 1936, the first applicable amount as calculated under subsection 245-55(2) can be less than the face value of the debt where, because of the debt's fixed term and fixed interest rate, the value of the debt has become less than the prevailing market rate of interest.
Facts
In 2006 Debtor raised finance by issuing $10,000 unsecured notes carrying a fixed rate of return to unrelated creditors, including Creditor. The maturity date of the notes was 2016 and Creditor could only terminate the note earlier with the approval of Debtor. At all times Debtor had the capacity to pay all its debts as and when they became due.
In 2009, because of the Global Financial Crisis, the rate of the return on the notes became far less than the prevailing rate of interest that would have been payable on notes with otherwise equivalent terms.
Having surplus funds available Debtor made a public offer to all the holders of the notes to redeem them at a discount to their face value. Having severe liquidity problems Creditor (and others) accepted the offer as it was unable to sell the note for more than the amount offered by Debtor.
Sections 245-60 and 245-61 of Schedule 2C to the ITAA 1936 do not apply to these debts. Debtor was not entitled to any deduction for the purposes of paragraph 245-55(3)(b) of Schedule 2C to the ITAA 1936 in respect of market variables.
Reasons for Decision
The notional value of a debt under subsection 245-55(1) of Schedule 2C to the ITAA 1936 is the lesser of the first applicable amount calculated under subsection 245-55(2) and the second applicable amount calculated under subsection 245-55(3).
The first applicable amount is to be determined on the assumption (as per the facts of this case) that Debtor had the capacity to pay all its debts when the debts were incurred and when they were forgiven.
Although Debtor had the capacity to fully repay its debts, the value of Creditor's note had become less than its face value because the fixed interest rate it carried was less than the relevant prevailing interest rate and Creditor had no power to demand either its early repayment or an increase in its interest rate. In view of the fact that Creditor was unable to sell the note for a greater amount to a third party it is considered that the value of the note as an asset of Creditor at the time of forgiveness upon redemption is the amount paid by Debtor.
The second applicable amount is to be determined on the assumption that there has been no change in the market variables prior to the forgiveness of the debt. If the market variable of interest rates had not changed due to the Global Financial Crisis, the value of the notes would have remained the same, being their face value. The second applicable amount is therefore the face value of the debt.
As the first applicable amount being the amount paid by Debtor to redeem the note is less than the second applicable amount (face value of the debt) the notional value of the debt is the discounted amount paid by the Debtor upon redemption.
Date of decision: 24 February 2011Year of income: Year ended 30 June 2009
Legislative References:
Income Tax Assessment Act 1936
Schedule 2C subsection 245-55(1)
Schedule 2C subsection 245-55(2)
Schedule 2C subsection 245-55(3)
Schedule 2C paragraph 245-55(3)(b)
Schedule 2C section 245-60
Schedule 2C section 245-61
Keywords
Debt forgiveness
ISSN: 1445-2782
Copyright notice
© Australian Taxation Office for the Commonwealth of Australia
You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).
